What is a CD?
CD stands for Certificate of Deposit. CDs allow an investor to deposit funds with a bank, and earn a secure, potential rate of return over an established amount of time.
CDs are secure because they are insured by the Federal Deposit Insurance Corp. (FDIC). And the rate of return is awarded if you meet the agreed upon time, also known as terms, of the CD.
How is a CD different from a Savings account?
Like a savings account, a CD is a vehicle to hold your cash savings. Unlike a standard savings account, a CD typically earns a higher rate of interest. Banks can pay higher rates in return for holding your lump sum deposit for an agreed upon period of time, whether months or years.
Sounds great, right? But is a CD right for you?
First determine if your current savings will allow you enough of a cushion to move into a long-term vehicle. Typically, banks require a minimum $1,000 deposit to open a CD. The current trend of CDs' return on interest provides and attractive alternative to many traditional savings plans.
Young investors are often discouraged by the idea of placing their savings out of reach. Emergency expenses and immediate large, impulse purchases often take precedence over long-range goals such as a down payment for a new home, or tuition for a child's education. Young investors may be more likely to place their money in the stock market. Their money may be more easily pulled from an investment, but the volatility of the market doesn’t guarantee reward.
A short-term CD might offer a more secure alternative for a young investor. Many CDs have terms as brief as 3 months to 5 years. Longer term CDs typically have the highest yields, but even short term CDs typically yield much better than a traditional savings account.
If an unaccounted emergency should arise, you would still have access to your money. However, you should expect a penalty for early withdrawal. This would mean a partial or entire loss of interest depending on how much of the terms were met and how much money is withdrawn from the CD. Keep in mind the penalty could be greater than the interest accrued at the time of withdrawal and might affect the principal.
Investors who have accumulated a comfortable savings which is not likely to be affected by emergency spending have an opportunity to deposit sums into a long-term CD. In recent years, the Federal funds rate has risen to a rate that allows banks to make CDs a more attractive investment for meeting long-term goals.
How does the Fed fund rate work? The Federal Reserve Board issues short-term target rates, the Federal fund rate, which allows depository institutions to lend to other depository institutions overnight. The temporary nature of these inter-institution loans allows for a higher rate of return for your long-term personal investments.
There are some very attractive interest rates available on 3-to-5-year CDs in the market place. Balancing your CD investments across multiple terms can be a great way of targeting different goals, while maintaining control of how long funds are out of reach until they reach maturity.
There are many scenarios where you might receive an unexpected windfall. Inheritance, performance bonuses, maybe even a winning lottery ticket; there are times when you find extra income is simply icing on the cake. CDs provide a safe vehicle to grow your investment until you determine the best use for the extra savings.
Depending on how large your newly found treasure, you may want to break down your investments into multiple CDs and even across multiple institutions. FDIC insurance is available. Speak with a financial planner to learn more about saving and investing.
There are many banking institutions out there that offer CD investment opportunities. Bank Independent would like to encourage you to review our current CD rates. We would be happy to review our offerings with you and learn more about your plans to meet your investment goals. Or, if you know what you need, you can open an account online today.